Economic Factors, from Local to Global, Affect CRE
With the election over many people have expressed concerns over the state of the economy and how this may affect commercial real estate. Of more importance I believe is the state of the global economy. This combined with other factors, U.S., global, and regional economic pressures may have an adverse effect on real estate. Economic conditions affect all businesses and typically smaller businesses feel the impact greater and faster than their larger competitors.
Local Economy: Retail rental rates are at an all-time high in many major metros, including the Greater Los Angeles Metro. Can these increases in rents be sustained? I don’t believe so, as there are many other outside pressures to cut retail rental rates. Within California, the Fair Wage Act that was recently passed will definitely have an impact on retailers. Most retailers pay minimum wage to their employees, and outside of cost of goods and rent, wages are typically the highest expense for a retailer. The passage of the Fair Wage Act will eventually increase this expense by 50%. This comes at a time when many brick and mortar retail shops are experiencing an enormous amount of competition from E-Retailers. Many retailers will look to first cut expenses by reducing their largest expense, rent.
National Economy: With interest rates rising, many consumers are concerned over the price of goods, buying slows, which in turn cuts into the profitability of retailers. The overall impact is that concern over job stability causes consumers to be more cautious with the expenditures, cutting into the profit stream for the retailers. This also makes it harder for smaller retailers to qualify for loans for either expansion, or capital expenditures to existing locations. Many will be forced to downsize, which may further negatively impact the economy (loss of jobs, higher unemployment).
Global Economy: OPEC recently announced that they will be cutting production of oil, and for the first time in 15 years, Russia joined with OPEC and announced they will also cut production by 300,000 barrels/day. Of course, with basic supply and demand rules, if there is less supply and demand remains constant, prices will increase. How will an increase in oil prices affect commercial real estate? Many people just associate oil with gasoline, but we use oil for many other aspects. Prices to deliver products will increase, but so will construction cost (oil for rubber, road repairs, even roofing materials). An increase in oil costs will adversely affect real estate. Yes, prices may increase for newer buildings (due to increase in materials), but to compensate will retailers be able to pay more rent? I don’t think so due to the current local and national economic outlook.
What is an investor to do in this scenario? Well, if history has taught us anything, it is that real estate over time appreciates. When an investor is looking to invest in real estate I believe that location is still one of the most important factors. Also, when underwriting the viability of the real estate, an investor really needs to look at the current tenants, their business, and their future business model. How adaptable is the tenant to changing economic climates? What plans does a tenant have to survive a downturn in the economy, and lastly, is their product/service recession proof? Now, more than at any time in the last 8 years, it is of utmost importance for an investor to underwrite a tenant’s business as much as the building’s location.